China / Hong Kong Industry Focus China Brokerage Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 7 Jul 2020 Deepening SOE reform the next catalyst HSI: 25,976 • The initiation of three-year SOE reform plan to deepen SOEs’ mixed-ownership reform implies precursor for more funding activities to come ANALYST Ken SHIH +852 36684184 [email protected] • With SOEs contributing 42% of the market’s total Sam LU +852 36681253 [email protected] fund-raising year-to-date, we estimate market size to reach Rmb1.1tr/Rmb1.5tr in FY20/21F Recommendation & valuation • Revise up FY20F trading volume/margin trade growth forecast to +30%/+15% y-o-y Closing T arget % DBS Price Price upside/ • Raise China brokers’ FY20-21F earnings by 4%- Stock T ick er Rating (HKD) (HKD) downside 13% and lift TPs by 14%-49%; BUY CITIC (6030 CITIC - H 6030 HK BUY 19.28 25.80 34% HK), CICC (3908 HK) and CSC (6066 HK) CICC - H 3908 HK BUY 18.10 23.10 28% Growth in A-share market capitalisation expected. China CSC -H 6066 HK BUY 11.74 14.85 26% announced a new 3-year reform plan to further deepen SOEs’ China Galaxy - H 6881 HK BUY 5.60 7.50 34% mix-ownership reform during the two-session this year. This GF - H 1776 HK BUY 9.91 12.40 25% marks the beginning of further fund-raising activities from Haitong - H 6837 HK HOLD 8.30 8.80 6% SOEs in coming years. In 2019, A-share’s market capitalisation– Huatai - H 6886 HK HOLD 15.12 15.80 4% to-GDP ratio was at 0.6x, versus peers’ average of 1.1x. With Guotai Junan -H 2611 HK HOLD 13.38 14.00 5% SOE stably accounted for 40% of the total fund-raising market, the potential for A-share market capitalisation’s to grow Source: Thomson Reuters, DBS Bank (Hong Kong) Limited (“DBS HK”) remains substantial. Fund-raising market to exceed previous expectations by 14%. Secondary public offerings (SPO) and convertible bonds (CB) are two major means of fund-raising for SOE and accounted for 77% of total funds raised YTD. With 1) SOE’s 1H20 funding pipeline reaching Rmb400bn, 2) expect Rmb268bn funds to be raised in 2H20F, 3) 323/305 processing days for mainboard/CB, and 4) 3.6x faster processing time for ChiNext, we estimate the fund-raising market to grow to Rmb1.1tr/ Rmb1.5tr in FY20/FY21F, 14% higher than expected and returning to FY15 level. Positive earnings outlook ahead. Driven by the ample market liquidity and recent stock market rally, China A-share’s daily turnover in the first week of July was higher than expected at Rmb1tn, compared to Rmb754bn/ Rmb549bn in 1H20/FY19. Similarly, margin trade balance reached Rmb1.2tn during the same period, up 13% compared to end of FY19. As such, we revised up FY20F trading volume/margin trade growth forecast to +30%/+15% y-o-y (from +15%/+5% y-o-y previously). Raise TPs by 14%-49%; BUY CITIC, CICC, and CSC. We revised up China brokers’ FY20-21F earnings by 4%-13%, to factor in upside from SOE fund-raisings, and higher turnover/margin trade growth. By rolling over the valuation base to FY21F, we raise China brokers’ target prices by 14%- 49%. We maintain our positive sector view and reiterate BUY on CITIC, CICC and CSC. ed-TH / sa-CS / DL Industry Focus China Brokerage Sector Initiating 3-year plan to deepen SOE mixed-ownership investment banking business opportunities for China’s reform brokerage industry. The most recent “Report on the Work of the Government” Fig. 1 Efforts made in the last round of mixed-ownership th delivered at the third session of the 13 National People’s reform Congress on May 22 laid out the execution of another 3-year SOE reform plan to further enhance the effectiveness of the Date Topics Key Details previous reform. In details, the central government and state Feb "Ten Reforms" Started mixed-ownership and council will further deepen the mixed-ownership reform, 2016 Pilot Zone employee stock ownership in explore and build a new corporate governance mechanism and industries including energy, supervision policy to fit mixed-ownership SOEs. Also, SOEs are railway, aviation, and telecom encouraged to focus on their own key businesses, to optimise Oct 1st round of Nine companies confirmed, marketized operations, and to finally improve their core 2015 mixed-ownership including: pilot companies China Eastern Airline, China competencies. Following the execution of the first round of 5- Unicom, China Southern Power year SOE reform since 2015 (figure 2), more than 3,700 mixed- Grid, Harbin Electric Corporation, ownership projects have been settled. However, the breadth China Nuclear Construction, and and the quality of the mixed-ownerships have room to China State Shipbuilding improve. We believe the new 3-year plan will break years of Corporation threshold to SOEs, that are policy-backed to have clear Dec Subsidiaries of 10 Subsidiaries of Central SOE separation between political and business decisions within 2016 Central SOE committed to establishing SOEs, to improve market-driven level, and to energise SOEs to employee stock employee stock ownership become more competitive at the international level. ownership pilot projects companies Looking back, China only started to mention about SOE mixed- Apr 2nd round of 10 companies confirmed such as: ownership reforms since 2013 and began to execute detailed 2017 mixed-ownership Cguba CRRC group, Air China pilot companies Cargo, China National Gold implementations since 2015 with the hope to enhance Group Gold Jewellery, and efficiency and effectiveness of corporate governance and thus COFCO improve overall productivity. As of 2019, there were four Nov 3rd round of Confirmed 31 companies, which “Opinion” documents to drive the mixed-ownership reform, 2017 mixed-ownership included 10 central SOEs and 21 regulating the key objectives and detailed operations of SOEs pilot companies local SOEs (Figure 2). May 4th round of Confirmed 160 companies, 2019 mixed-ownership including 107 central SOEs and 53 During the last 5-year reform, the central government pilot companies local SOEs implemented several rounds of mixed-ownership pilot operations to steadily enable companies to initiate mixed- Source: State Council, DBS HK ownership reform. Based on SASAC’s data, over 3,700 mixed- ownership projects have been settled, attracting over Rmb1tr of public capital, with over 70% of SOEs undergoing mixed- Substantial room for A-share market cap to grow ownership reform. Some 65% of SOE assets have been In 2019, China A-share market capitalisation to GDP ratio injected into listed companies, with 61% of revenue and 88% (using year-end closing price) reached 0.6x (figure 3). of profits coming from listed companies. Therefore, after five Compared to major peers’ average of 1.1x, this indicates that years of efforts, China SOEs are basically entering the mixed- China’s A-share market capitalisation has substantial room to ownership era. However, in practice, some SOEs are still grow. We believe the growth in market capitalisation may reluctant to adopt mixed-ownership reforms or apply only to come in the following ways: a) growth in the number of listing deal with policies. We believe the new round of reform, which companies (namely from IPO), b) growth from the issuance of aims to enhance the “effectiveness” of the reform, will highly existing securities (namely, SPO and CB), and 3) growth in drive or even force the rest of the SOEs to adopt the mixed- listed companies’ market values. Either way, this is positive to ownership reform, therefore creating more fund-raising-related China brokers. Page 2 Industry Focus China Brokerage Sector Fig 2. Four “Opinion” documents to drive the mixed-ownership reform Date Topics Key Details Reference Sep 2015 Overall opinion on mixed- 1. Encourage valid SOEs to adopt mixed-ownership reform 关于国有企业发展混合所有制 ownership reform 2. Defined details of mixed-ownership methods to SOEs 经济的意见 3. Encourage public capital to participate in mixed- ownership projects Oct 2015 Attract non-SOE capital Provided further details on the following: 关于鼓励和规范国有企业有子 investment 1. Principle of financing 项目引入非国有资本的指导意 2. Domains of collaboration 3. Process of financing 见 3. Decision process Aug 2016 Employee stock ownership Details on regulation of: 关于国有控股混合所有制企业 1. Range of employee stock ownership 开展员工持股试点的意见 2. Pricing 3. Stock ownership management Nov 2017 Refinement of mixed- Further regulation of: 关于深化混合所有制改革试点 ownership pilot projects 1. Asset pricing 若干政策的意见 2. Land disposal 3. Employee stock ownership and remuneration Source: DBS HK Market size to reach Rmb1.1tr/Rmb1.5tr in FY20/21F Fig 3. Market capitalisation/GDP by major markets SOEs have several ways to apply their mix-ownership reforms (x) and to attract external investments, including launching IPOs, 3.5 SPOs, and issuing convertible bonds. In FY19, China settled a total fund-raising (including IPO, SPO, and convertible bonds) 3.0 of Rmb1.2tr, and YTD the number is Rmb424bn. During the 2.5 period, SOEs (including local and central SOEs) completed a 2.0 total fund-raising of Rmb475bn respectively in FY19, 1.5 representing 39% of the total fund-raising, and were the 1.0 Avergae = 0.7x second-largest group, just slightly smaller than the whole private enterprise group (figure 4). Looking back at the last 0.5 round of SOE reform since FY15, the SOEs’ percentage of 0.0 fund-raising stayed stable at 30-40%, keeping them as the USA second-largest group. India Brazil Spain Japan China Russia France Canada Norway Thailand Vietnum Malaysia Australia Germany Indonesia Philippine Singapore Switzerland South Africa South Korea South Luxembourg New Zealand New Source: Bloomberg Finance L.P., DBS HK Page 3 Industry Focus China Brokerage Sector Fig 4.